British government relying too heavily on business to make society fairer

17 May 2018

By Barnali Choudhury and Martin Petrin

The UK is introducing new legislation that will require companies to publish the ratio of what they pay their CEO compared to the average worker’s salary. The move follows a number of corporate governance reforms introduced by the government over the last year and a half as part of an effort to build a fairer economy. But if the government was truly committed to building a fairer economy, it would not rely primarily on companies to do its work for it.

When Theresa May first became prime minister, she vowed to reform the UK’s economy to ensure that it would work for everyone. Reforming the way that companies operate is a key part of this vision. According to May, corporate governance mechanisms are the tools by which these responsibilities should be imposed.

May is not alone in her views on the usefulness of corporate governance mechanisms to promote public responsibilities. Countries around the world, from India to France to the US, rely on these mechanisms to advance public interests – from protecting the environment to promoting humanitarian aid.

The UK’s Taylor Review into modern working practices even argued that corporate governance – and not government regulation – was the best way to reform work in the UK. There seem to be few ills of society that governments believe cannot be addressed through corporate governance.

The latest set of corporate governance initiatives aligns with the government’s views on its usefulness to address public problems. The ratio of CEO to worker pay requirement is being introduced, in part, to tackle the wide disparity in pay between executives and ordinary working people. This is not surprising, as CEO pay has increased by 82% over the last 13 years and today the average CEO makes 120 times as much as an ordinary worker.

Corporate governance tools are also being used to level the playing field between men and women. Since 2011, the government has recommended that companies increase the number of women on their corporate boards and more recently required companies to disclose the gender pay gap in their companies. Plus, corporate governance regulations are being used to promote myriad other issues relating to the environment, society, and communities.

If the government is truly committed to keeping executive pay in check, it shouldn’t leave it to companies to distribute their wealth more fairly

Of course governments have broad discretion to use any type of regulation to achieve public policy goals. But we question whether public-oriented corporate governance rules are the best way forward. This is because this approach can lead to three problems.

First, this approach may not be enough to change corporate behaviour. For instance, despite countless attempts by the government to regulate executive compensation, a recent study found that neither the pay gap between CEOs and employees has narrowed nor has the relationship between executive compensation and firm performance improved.

Second, current corporate governance mechanisms rely mainly on an indirect regulatory model, through disclosure. For instance, the new rules only require companies to disclose their CEO to worker pay ratio; they do not require companies to actually change the ratio of pay between the CEO and workers. Instead, the hope is that by having to reveal this information, companies will be prompted (or shamed) to reduce this disparity on their own.

If the government is truly committed to keeping executive pay in check, it shouldn’t leave it to companies to distribute their wealth more fairly. Instead, it could have more direct approaches such as capping the upper limits of executive pay or establishing acceptable pay ratio requirements between the lowest paid employee and the CEO.

Third, and most concerning, governments may be hiding behind these corporate governance rules to give the appearance of progress, instead of working to eradicate the root causes of these problems. For instance, despite executive pay continuing to rise the government continues to introduce further reporting requirements. Conversely, the government seems less interested in addressing the reasons for the widening inequality between employees and executives, such as zero hour contracts or the lack of a true living wage.

In these cases, corporate governance tools may be no better than good public relations. They appease the public and, given their toothless nature, do not subject governments to pressure from businesses.

If the government really wants to build a fairer economy, relying only on corporate governance rules is not the answer. In many instances, it is more effective to address the issue directly rather than relying on shaming and nudging techniques.

Overall, corporate governance tools are not a one-stop shop to fix the ills of society. They should only be used strategically and form part of a concerted, multifaceted effort to address the root of public policy issues.

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